Bracewell Tax Report - November 2018

Bracewell LLP

The Bracewell Tax Report is a periodic publication focused on developments in federal income tax law, including the recently enacted Tax Cuts and Jobs Act, with emphasis on how such developments impact the energy, technology and finance industries. The publication provides summaries of changes in tax law and its interpretation, as well as related practical guidance critical to making strategic business decisions and negotiating transactions.

Week of November 5

  • Featured Articles
    • IRS and Treasury Department Release Proposed Regulations on Opportunity Zones
    • Coming out of the Dark: Energy Storage and Renewable Tax Credits
  • Additional Reading
  • Future Topics

Featured Articles

IRS and Treasury Department Release Proposed Regulations on Opportunity Zones
By Liz McGinley and Steven Lorch

On October 19, 2018, the IRS and Treasury Department released highly-anticipated proposed regulations (the Proposed Regulations) under Section 1400Z-2 of the Internal Revenue Code of 1986, as amended (the OZ Statute). The OZ Statute, which was enacted pursuant to the Tax Cuts and Jobs Act, offers tax incentives to encourage private investment in qualified opportunity zones (QOZs), which are certain low-income communities designated by the Treasury Department. 

The OZ Statute initially was met with great enthusiasm from taxpayers that saw opportunities to recognize gains without current tax liability, reinvest such gains, and potentially be subject to a reduced effective rate of income tax on such gains when they ultimately are recognized. The OZ Statute, however, was long on promise and short on details. The Proposed Regulations, which provide clear and practical guidance on the scope and application of the OZ Statute, have been well received by taxpayers, practitioners and commentators alike. Although many questions remain, the Proposed Regulations should provide most taxpayers with sufficient guidance to obtain the benefits of the OZ Statute. Additional regulations with respect to the OZ Statute are anticipated by year end. 

Primary Tax Benefits under the OZ Statute
The OZ Statute provides three primary tax incentives to encourage taxpayers to reinvest capital gains in qualified opportunity funds (QOFs). First, a taxpayer may elect to defer U.S. federal income tax on capital gains, to the extent such capital gains are reinvested in a QOF, until the earlier of the taxpayer’s disposition of the QOF investment or December 31, 2026. 

Second, a taxpayer that elects to defer such capital gains may receive an increase in its tax basis in the QOF investment equal to 10% of the gain initially deferred if the QOF investment is held for 5 years prior to December 31, 2026, and an additional increase in tax basis equal to 5% of such deferred gain if the QOF investment is held for 7 years prior to December 31, 2026. A taxpayer therefore could eliminate up to 15% of the capital gain that was deferred in connection with the initial QOF investment. Because the deferral period ends on December 31, 2026, however, taxpayers must make investments in QOFs no later than December 31, 2019 to be eligible for the full 15% exclusion.

Third, if a taxpayer holds the QOF investment for at least 10 years, the taxpayer may elect to increase the tax basis in the QOF investment to its fair market value. As a result, any appreciation in the QOF investment (that is, gain in excess of the initial deferred gain) generally would never be subject to U.S. federal income tax.

Qualified Opportunity Funds 
A QOF must be classified as a corporation or a partnership for U.S. federal income tax purposes. It also must be organized in one of the 50 U.S. states, the District of Columbia or one of the U.S. possessions. If an entity is organized in a U.S. possession, it will qualify as a QOF only if it is organized for the purpose of investing in qualified opportunity zone property (QOZ Property) that relates to a trade or business operated in the U.S. possession in which such entity is organized. 

In addition, at least 90% of a QOF’s assets must be comprised of QOZ Property (the “90% Test”). For purposes of the 90% Test, the QOF must determine the fair market value of its assets based upon financial statements filed with the SEC, or any federal agency other than the IRS, or certified audited financial statements under certain circumstances. Otherwise, the QOF must use the cost basis of its assets for purposes of the 90% Test.

The OZ Statute provides that QOZ Property includes three asset classes: qualified opportunity zone business property (QOZ Business Property), qualified opportunity zone stock (QOZ Stock), and qualified opportunity zone partnership interests (QOZ Partnership Interests). The Proposed Regulations clarify and refine the scope of the three asset classes, as follows:

  • QOZ Business Property: tangible property used in a trade or business of a QOF if (1) the QOF purchases the property after December 31, 2017, from an unrelated person, (2) the original use of the property in the QOZ commences with the QOF, or the QOF substantially improves the property, and (3) during substantially all of the QOF’s holding period for such property, substantially all of the use of such property was in a QOZ. For this purpose, property is treated as substantially improved only if, during any 30-month period beginning after the date of acquisition, the new basis of the property attributable to improvements made by the QOF, on the one hand, exceeds the initial adjusted basis of the property in the hands of the QOF at the beginning of the 30-month period, on the other hand. The Proposed Regulations add that basis attributable to land is disregarded in the calculation of substantial improvement.
  • QOZ Stock: stock acquired by a QOF, solely for cash, from an entity classified as a corporation for U.S. federal income tax purposes. The exchange must occur after December 31, 2017 and, at the time of issuance, the corporation must conduct a QOZ Business (as described below) or, in the case of a new corporation, be organized for purposes of conducting a QOZ Business. During substantially all of the QOF’s holding period for such stock, such corporation must qualify as a QOF Business.
  • QOZ Partnership Interests: partnership interests acquired by a QOF, solely for cash, by an entity classified as a partnership for U.S. federal income tax purposes. The exchange must occur after December 31, 2017 and, at the time of issuance, the partnership must conduct a QOZ Business or, in the case of a new partnership, be organized for purposes of conducting a QOZ Business. During substantially all of the QOF’s holding period for such partnership interest, such partnership must qualify as a QOF Business.

To be treated as conducting a QOF Business, substantially all of the tangible property owned or leased by a corporate or partnership subsidiary of a QOF must be QOZ Business Property. For this purpose, the Proposed Regulations provide that “substantially all” means 70%. Accordingly, to the extent a QOF invests in a corporate or partnership subsidiary, it would have more flexibility in its direct and indirect asset ownership than if it held all of its assets in the form of QOZ Business Property. For purposes of this 70% test, valuation rules similar to the 90% Test apply. 

In addition, to be treated as conducting a QOF business, such a corporate or partnership subsidiary must (1) derive at least 50% of its total gross income from the active conduct of a trade or business in a QOZ, (2) use a substantial portion of its intangible assets in the active conduct of a trade or business in a QOZ, and (3) hold less than 5% of its property as nonqualified financial property, which includes debt, stock, partnership interest, warrants, notional principal contracts and other similar property. For purposes of the requirement regarding nonqualified financial property, the Proposed Regulations include a safe harbor for reasonable working capital held in cash, cash equivalents or debt instruments with a term of 18 months or less. Under the safe harbor, such working capital assets are not treated as nonqualified financial property if (1) there is a written plan that identifies such working capital assets as held for the acquisition, construction, or substantial improvement of tangible property in a QOZ, (2) there is written schedule consistent with the ordinary start-up of a trade or business for the expenditure of such working capital assets within 31 months of the receipt by the business of the assets, and (3) the trade or business substantially complies with such written schedule.

Finally, the Proposed Regulations provide that a corporation or partnership must self-certify its status as a QOF on an IRS Form 8996, a draft of which was released with the Proposed Regulations, and this form must be attached to the corporation or partnership’s U.S. federal income tax return for each year that the QOF determination is made. 

Qualifying for QOZ Tax Benefits under the Proposed Regulations
The OZ Statute, together with the Proposed Regulations, provide that, to qualify for QOZ tax benefits, an Eligible Taxpayer must reinvest Eligible Gains from the sale or exchange of an asset into an Eligible Investment within the Statutory Period, and file a Deferral Election (each as described below). The Proposed Regulations clarify the meaning of such terms, as follows:

  • Eligible Taxpayer: any taxpayer that recognizes capital gain for U.S. federal income tax purposes, including individuals, corporations (including RICS and REITs), and partnerships. The Proposed Regulations clarify that, if a partnership does not elect to invest eligible gains in a QOZ, a partner may invest its share of such gains in a QOF, and provide procedures for such partner to make the Deferral Election (as defined below).
  • Eligible Gain: capital gain realized from an unrelated person that would be recognized no later than December 31, 2016. The OZ Statute was unclear whether ordinary income, including, for example, depreciation recapture, would be eligible for reinvestment into a QOZ. The Proposed Regulations confirm that only capital gains, either short term or long term, are so eligible.
  • Eligible Investment: any equity interest in a QOF, including preferred stock or a partnership interest. An equity interest in a QOF will not fail to qualify as an Eligible Investment if the interest is used as collateral for a loan, as long as the Eligible Taxpayer is treated as owning the interest under U.S. federal income tax principles. The Proposed Regulations clarify that neither a debt investment in a QOF nor a deemed capital contribution under Code Section 752(a) will constitute an Eligible Investment for this purpose.
  • Statutory Period: 180 days after the date when the Eligible Taxpayer would have recognized the Eligible Gain, without regard to the Deferral Election.
  • Deferral Election: an election filed on IRS Form 8949 and attached to the taxpayer’s U.S. federal income tax return for the taxable year when the Eligible Gain would have been recognized, without regard to the application of any QOZ tax benefits.

Looking ahead
While the Proposed Regulations answer many questions raised by the OZ Statute, additional guidance will be needed. Notably, further clarification is needed with respect to the application of the OZ Statute to Eligible Investors and QOFs that are classified as partnerships for U.S. federal income tax purposes, particularly pooled investment vehicles, such as private equity funds, that seek to reinvest capital gains in QOFs. The IRS and Treasury Department have promised additional guidance, including in the form of further proposed regulations, in the near future.

Effective Date
The OZ Statute became effective on January 1, 2018. If finalized, the Proposed Regulations would apply to transactions that occur on or after the date the Proposed Regulations are finalized. Taxpayers may rely on the Proposed Regulations prior to the date they are finalized, so long as taxpayers apply the Proposed Regulations in their entirety and in a consistent manner.

Coming out of the Dark: Energy Storage and Renewable Tax Credits
By Michele Alexander, Ryan Davis and Catherine Engell

The increased demand for energy from renewable sources and the resulting growth of the renewable energy industry has led to the development of an increasing body of law designed to address issues specific to this sector. Recently, questions have come to the forefront regarding the treatment of technology developed in order to store energy produced from renewable sources. 

Certain limitations still exist that inhibit the industry’s growth despite the advances made in renewable energy technology and the best efforts of the sector’s governmental and non-profit advocates. Primary among these limitations is the difficulty of storing the energy produced through renewable sources for later use with the goal of providing a consistent source of power that may be drawn on as demand requires. Development of and advances in energy storage technology may help pave the way for renewable energy to serve as the primary source of electricity for a population center, rather than merely bolstering the supply produced through traditional power plants. As a result, energy producers and lawmakers alike have taken a keen interest in the tax treatment of energy storage devices, particularly with respect to their eligibility for certain benefits or subsidies available in connection with property used in the actual generation of energy from renewable sources (and not merely its storage). Increasingly, tax law, while initially behind the times, is beginning to catch up with the technology. However, questions still remain.

In general, renewable energy producers may choose between the Production Tax Credit (PTC), which provides a tax credit based on the amount of energy produced, and the Investment Tax Credit (ITC), which provides for a tax credit equal to 30% of the basis in an energy property (defined here) in the year it is placed into service.1 An energy property is deemed to be “placed into service” in the taxable year during which either (i) depreciation begins or (ii) the property is in a state of readiness and availability for its function.In the case of energy storage devices, where energy is stored rather than produced, taxpayers historically have only claimed the ITC, the applicability of which is contemplated in the regulations with respect to both wind and solar and subsequent Private Letter Rulings.3

As a result, the primary questions with respect to the availability of tax credits for batteries and other energy storage property have not centered on eligibility or which credit to use, but rather how the credits could be utilized with respect to functioning energy property that is retrofitted with energy storage capabilities. Specifically, how do we reconcile the fact that a battery is considered to be “qualified energy property,” and therefore eligible for the ITC under the applicable Treasury Regulations, with the fact that it is not clearly integral to the function, the production and transmission of energy, of said energy property. The situation becomes even more unclear in cases where preexisting energy property that already produces and transmits energy is retrofitted with energy storage devices. How does one argue that the battery is “integral” to this energy property that was clearly functioning without storage capabilities? Could a battery by itself be separately creditable from the energy property to which it is attached, and, as a result, could a taxpayer take advantage of the ITC with respect to a retrofitted battery even if already electing to utilize the PTC with respect to the preexisting energy property? Fortunately, the IRS has favorably ruled with respect to the first two questions, leading to optimism, but not certainty, with respect to the third. In order to further consider that question, it is helpful to review the rationale of the IRS in addressing the first two inquiries, particularly its detailed consideration of the benefit provided by energy storage relative to the energy property.

What Has Been Illuminated
With respect to the first question, in PLR 201142005, a taxpayer who was in the process of constructing a utility-scale wind project sought guidance from the IRS regarding the eligibility of energy storage equipment which was to be included in the project for the ITC. As described in PLR 201142005, the device would charge when wind speeds were high and discharge when they fell. According to the IRS, the storing of electricity for use at a later time is a classic use of a battery and therefore the energy storage device in question fell directly under the applicable Treasury Regulations and was fully eligible for the ITC. Perhaps tellingly, the IRS also discussed at some length the way in which the wind project was being built in order to supply energy to an electric grid that served nearby municipalities. In order to be selected to sell energy to this grid, the project needed not only the ability to meet forecasted demand, but also the ability to respond to the real time demand of an electric grid in a similar manner to nonrenewable energy power plants (an capability for which it would be paid additional compensation). In other words, in order for the wind project to fulfill this requirement, a battery was indeed necessary and, therefore, the storage device could be considered integral to the energy project in the particular instance. The IRS has mirrored this sentiment with respect to solar property. In PLR 201444025, the IRS similarly found that storage devices that were included in solar energy property were necessary in order for the solar energy property in question to optimally function.

How does this rationale apply in situations where existing renewable energy property, which clearly was functioning in the absence of a battery, is retrofitted with a storage device? In PLR 201208035, similar to the situation outlined above, a utility-scale wind project was seeking to sell energy to an electric grid. Like other wind energy producers, this project suffered from transmission constraints when there were low wind speeds, which limited its ability to act as the electric supplier to nearby municipalities. The developer retroactively added a storage facility to solve this issue. Not only would the addition of the storage device solve the transmission problem, it also would allow the producer to shift the time of the transmission from off-peak hours (when most of the wind energy was produced) to peak hours when the grid would pay a higher price for the electricity. Finally, it also would allow the wind farm to have more control over the flow of its electricity, which the grid required of its producers. Using rationale identical to that which it applied to the instances where batteries were included in the energy property from the outset, the IRS found that the storage devices were fully eligible for the ITC in the year such devices were included. Again, although the property was functioning prior to the addition of the battery, it was not functioning optimally and its shortcomings could decrease its earnings or result in it losing the opportunity to act as an energy supplier to the grid. As a result, the battery was necessary for the energy property to be fully functioning and to fulfill its intended purpose of supplying energy to the electric grid in question. 

PLR 201308005 dealt with this issue as it related to solar energy. The taxpayer in this case was a large solar developer that leased constructed solar energy property to be attached to residences and businesses. The developer wanted to start including batteries on its solar energy projects so it could store energy that it produced during daylight hours and provide it during peak usage, the nighttime hours when the sun is not shining. The IRS specified four benefits the solar energy property would obtain from including batteries, including that the battery would allow (i) the energy property to store electricity from daylight that it then could then use during off-peak hours and then sell back any unused electricity to the grid, (ii) renewable energy producers to decrease the amount of energy it provides to the grid in situations where the amount produced fluctuates rapidly (as is required by most electric grids) and store the excess energy for later use rather than having it go to waste, (iii) for a stable flow of electricity to the grid (which is a particular difficulty for wind and solar developers) by allowing the grids to pull electricity from the battery when it needs and shed it to the battery when necessary, and (iv) the customer to limit its peak usage by pulling stored electricity to use during those times when electricity would cost more. Again, although the batteries were not included in the solar property originally, and are therefore obviously not technically integral to the functioning of the property, the IRS stressed the ways in which the addition of the battery would provide the energy project with the ability to function optimally.

Where We Remain in the Dark
While the guidance issued by the IRS clarifies the eligibility of storage facilities with respect to wind and solar projects which utilized the ITC, it remains unclear whether a retrofitted battery could take advantage of the ITC, even if the preexisting energy property is already utilizing the PTC. Specifically, is the energy storage device itself separately creditable or is it deriving its ability to take the credit because of the energy property to which it is attached? If the latter, would it then be possible for the battery to utilize the ITC if the device to which it is attached is not utilizing (or not eligible for) that tax credit? This is a particularly important issue for onshore wind producers who often derive a greater benefit from the PTC than the ITC. 

There is some reason to believe that this is the case. As discussed above, the IRS has allowed a taxpayer to utilize the ITC with respect to a retrofitted battery in a later year despite the fact that the taxpayer utilized the credit in connection with the existing energy property in the year that the existing energy property was placed into service. This treatment by the IRS lends credence to the idea that the battery itself is separately creditable and not merely viewed as an extension of the preexisting energy property. However, until the IRS issues guidance where this issue is explicitly dealt with, onshore wind developers (and other energy producers that seek to utilize the PTC) will remain in the dark on whether they can retroactively add batteries and other storage technology and still be able to take advantage of the ITC with respect to that property. 

IRC Section 48(a)

Treas. Reg. 1.46-3(d).

See Treas. Reg. 1.48-9(d)(3); 1.48-9(e)(1); PLR 201142005; PLR 201208035; 201308005; 201444025.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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  • "Persistent cookies" - These cookies stay on your computer or device after your browser has been closed and last for a time specified in the cookie. We use persistent cookies when we need to know who you are for more than one browsing session. For example, we use them to remember your preferences for the next time you visit.
  • "Web Beacons/Pixels" - Some of our web pages and emails may also contain small electronic images known as web beacons, clear GIFs or single-pixel GIFs. These images are placed on a web page or email and typically work in conjunction with cookies to collect data. We use these images to identify our users and user behavior, such as counting the number of users who have visited a web page or acted upon one of our email digests.

JD Supra Cookies. We place our own cookies on your computer to track certain information about you while you are using our Website and Services. For example, we place a session cookie on your computer each time you visit our Website. We use these cookies to allow you to log-in to your subscriber account. In addition, through these cookies we are able to collect information about how you use the Website, including what browser you may be using, your IP address, and the URL address you came from upon visiting our Website and the URL you next visit (even if those URLs are not on our Website). We also utilize email web beacons to monitor whether our emails are being delivered and read. We also use these tools to help deliver reader analytics to our authors to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

Analytics/Performance Cookies. JD Supra also uses the following analytic tools to help us analyze the performance of our Website and Services as well as how visitors use our Website and Services:

  • HubSpot - For more information about HubSpot cookies, please visit
  • New Relic - For more information on New Relic cookies, please visit
  • Google Analytics - For more information on Google Analytics cookies, visit To opt-out of being tracked by Google Analytics across all websites visit This will allow you to download and install a Google Analytics cookie-free web browser.

Facebook, Twitter and other Social Network Cookies. Our content pages allow you to share content appearing on our Website and Services to your social media accounts through the "Like," "Tweet," or similar buttons displayed on such pages. To accomplish this Service, we embed code that such third party social networks provide and that we do not control. These buttons know that you are logged in to your social network account and therefore such social networks could also know that you are viewing the JD Supra Website.

Controlling and Deleting Cookies

If you would like to change how a browser uses cookies, including blocking or deleting cookies from the JD Supra Website and Services you can do so by changing the settings in your web browser. To control cookies, most browsers allow you to either accept or reject all cookies, only accept certain types of cookies, or prompt you every time a site wishes to save a cookie. It's also easy to delete cookies that are already saved on your device by a browser.

The processes for controlling and deleting cookies vary depending on which browser you use. To find out how to do so with a particular browser, you can use your browser's "Help" function or alternatively, you can visit which explains, step-by-step, how to control and delete cookies in most browsers.

Updates to This Policy

We may update this cookie policy and our Privacy Policy from time-to-time, particularly as technology changes. You can always check this page for the latest version. We may also notify you of changes to our privacy policy by email.

Contacting JD Supra

If you have any questions about how we use cookies and other tracking technologies, please contact us at:

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This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.